#bear spread

We're back with part 3 of our Vertical Spreads How To series.  In part 2 we discussed our minimum entry price rule of one third the width of the spread. Now let's take a look at the maximum entry price rule.

What is the most you will pay when entering a Vertical Spread?

When you are considering maximum price on entry with a vertical, you are looking at an aggressive spread.  Therefore, you will be looking at buying a Debit Spread.  The most we pay for a Debit Spread 99% of the time is half the width of the spread. 

Let's look at a few examples...

If we're looking at a bullish SPY spread on this mornings weak opening, we may be looking to buy the 114/115 Call Spread.  Since the width of the spread is 1 (115-114), the most we would be willing to pay is 0.50, or a $50 debit per spread.

Let's say we're bearish on Gold here and want to play it via a GLD vertical.  We're confident in our direction, so we want to play a bearish Debit Spread. We may buy the 182/185 Put Spread. This spread is 3 points wide (185-182), so the most we would pay is 1.50, or $150 debit per spread.

We cap ourselves out at half the width of the spread because anything above that is getting a bit too aggressive from a probability perspective. generally if you are paying half the width of the spread, your probability of success is 50% (give or take a few percentage points). 

Per our experience, it's not worth pursuing a spread that offers less than 50% probability of success for obvious reasons.  Frankly, we sell Credit Spreads with 55%+ probability of success more often than anything else.